Confidence is returning to stockmarkets this quarter almost as rapidly as it dissipated last year. The global economy is slowing, signals are mixed, but the data does not point to a 2019 recession. Investors’ attention might now be better focused on the imminent company results season. A slowdown could put a premium on businesses with genuine sustainable growth.
Reported numbers from many companies have been flattered by favourable adjustments to numbers. And some of the metrics used to incentivise company executives have moved away from organic growth, cashflow and standard accounting practice. When economic growth is strong and companies can make acquisitions or borrow cheaply, few questions are asked about genuine progress. But easy credit and flawed incentives mean that sales or earnings disappointments can trigger a cascade of surprises on cashflow and debt. Lower growth can drive a sharp revision of the value of goodwill and inventory. Credit is more stressed currently; raising capital is likely to be harder this year.
The next three months will bring a flurry of trading updates and company accounts, key to fundamental equity analysis. The conviction that supports holding good businesses through market volatility must be based on detailed research. Key elements of sustainable growth are capital discipline, cash generation and the ability to generate returns in excess of the cost of capital. Many good businesses operate in a structural growth niche, but analysis is still crucial to verify the numbers and business model.